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In the Bitcoin and Litecoin stock markets, nothing is as hot as mining operations. These typically come in two forms, either as mining companies or as mining bonds.
Note: If you have no idea by this time what a mining operation is, then you’ve like found the wrong article and should head over to something more basic.
Most people don’t really get the whole mining bond thing, though, so I thought I should write an article and explain how these work.
What are Bonds?
Most people understand what a share in a company is, but if you don’t, think of it simply as a partial ownership of the company. Whatever the company owns, you own, and whatever the company earns, you earn, of course relative to the number of shares you own and how many shares are issued. When the company decides it has sufficient free capital, they may pay out a portion of they money to share holders, and this payment is called a dividend.
When the company does well, either the price of each share goes up because the company has more money (and assuming a market that more or less prices a share based on company value) or the company has more money that can be paid out as dividends. Conversely, if the company does badly, the profit and thus value, price, and dividends go down.
A bond, however, is simply a loan that is issued as a stock market asset or security. Rather than going to a single bank or financial institution to get the complete loan, the issuer, who wants to raise money for something, issues bonds that are then purchased by multiple parties on a stock exchange or market. This reduces the risk to a single lender and is thus often an easier way to raise capital.
Note: They key difference here is that a share is ownership of the company while a bond is ownership in a loan.
For example, if someone wants to raise $1 million, rather than going to a bank to ask for one million in one application, they can issue 1 million bonds each valued at $1. Investors can then lend exactly as much as they want, anywhere from one dollar to a million dollars. Each share of the debt represents a an equal portion of the total debt.
A bond, as a loan, is also associated with payment of interest, often called the coupon. The issuer pays this interest to lenders to get the money. The interest can be variable, fixed, a combination the two, or any other form that is legally allowed.
Finally, bonds are most often redeemable, meaning the issuer can buy them back, which is essentially the same as repaying the loan. As for the coupon or interest, the terms of this repayment is subject to what is legal and desired by the issuer and the market.
And Mining Bonds?
Mining investments are one of the most popular asset types in the cryptocurrency world, but a lot of people do not seem to realize how they work.
Mining bonds are exactly like regular bonds in principle, but they often have a few differences from what the norm is in the financial markets. I’ll get back to those differences in a moment, but let me first explain briefly how mining bonds work.
In a mining bond, the interest paid for each bond is most often based on a certain output that mining produces. For example, a 1KH/s Litecoin bond will pay out whatever having a 1KH/s mining rig would earn you. The coupon or interest on a mining bond is variable and changes based on the difficulty of the mining of that coin. The higher the difficulty, the lower the coupon or interest.
However, one thing that many people seem to misunderstand is that bonds are not shares in the company. Once you buy a bond, you have a predetermined agreement that the issuer promises to pay. When you own a share in a company, the issuer promises to give you whatever is your share of the profits, but you don’t know in advance what this may be.
Because the rate of return is highly variable and also declining, assuming a rise in adoption and popularity of mining, mining bonds behave a bit different than regular bonds.
First, most mining bonds are perpetual whereas regular bonds are redeemable. This means that the issuer has no plan to repay you what you lend. Your only return from your lending is the coupon or interest. After all, as profitability of mining declines permanently and the equipment bought with the loan will fall in value, the issuer has no way of repaying the loan.
Note: The term perpetual is actually a protection for the issuer, even thought it sounds great to the lender because it sounds like you get money forever. To the issuer, however, it is a protection because it means they never have to repay the loan you give them.
Because of this lack of repayment, mining bonds often have incredible returns and may seem to be great investments compared to regular bonds. They may be, but for all mining bonds, the simple truth is that what you get in return will dwindle rapidly as the rate of mining increases globally.
Second, the return of your bond will never increase. This is important to understand and confuses people when they see that companies invest in ever growing mining farms while their bonds remain static at a certain level.
However, when you think about it, this is perfectly logical. Remember that the mining output is the interest on a loan. There is absolutely no reason why the issuer would want to increase how much they have to pay you no more than it would make sense for you to start paying more on your mortgage, even though the housing market may go down or up.
With a bond, you do not own what the issuer uses your money to buy. You own simply the coupon or interest or that loan plus, technically, the loan value itself (although in perpetual bonds, this is never repaid and should be considered sunk cost).
As long as the issuer keeps paying what the terms of the contract states, you have no claim to any additional payment for any reason.
A couple of mining bonds play a little benign trick on you. The explicitly increase the payment over time, either through a reinvestment plan or by stating that on a certain date or under certain conditions, the coupon or interest will increase.
This isn’t anything different from regular bonds, however, that have coupons or interests that change based on some condition.
For example, let’s say you lend me $10 and I will repay you 10% interest per year, which is fine, and you know exactly what you’ll get. However, I’ll also include a clause that if I win in the lottery, I will increase that payment to 20%, and that if I lose my job, I will reduce that to 5%. This is still fine as long as those terms are known to you in advance.
For bonds that do reinvestment, the situation is still very simple when you think about it. The reinvestment will keep your return at a more steady pace, but that reinvestment comes from money you would otherwise have received in interest, so you are not really getting anything more than you would if you simply got a higher interest and purchased more bonds.
Are Mining Bonds Really Mining?
Now that you understand how mining bonds are just like regular bonds, and that all bonds are simply loans on which the issuer pays a predetermined return, here’s a thought for you:
Mining bonds don’t have to mine at all, and that is perfectly all right. It’s not a scam, nobody is trying to trick you, and it doesn’t affect the profitability at all.
Note: Speaking of profitability, calculating that for a mining bond is no different than calculating the profitability of investing in mining equipment. Find a good calculator, add the return from the hash rate you get in the bond, add the cost of the bond as the cost of the equipment, and you’ll have your profitability.
You see, you do not own the equipment that the issuer buys with your money. To you, the issuer can use that money to go on vacation for a year or buy a new car. In fact, some mining bonds today don’t have a single piece of mining equipment.
What you own is a predetermined rate of return, which is defined as whatever that certain hash rate would have given you, had you operated a mine. As long as you get that return, it doesn’t matter to you whether the issuer gets that money from actually mining or from growing pot in their backyard (financially speaking, of course).
It is actually easier for the issuer of a mining bond to not mine at all. Instead, they can get your money, put that into something that has a better return, and just give you the return to which you are entitled.
Some people see this as a scam, but really, it is nothing of the sort. A bond, no matter what you put in front of it, is simply a loan and you forfeit any decision over what the issuer buys with that loan the minute you sign the contract by placing a buy order.
I hope this helps clear up some of the confusion around mining bonds, but as always, feel free to leave comments if you have questions, comments, or other feedback
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